Premium Brands Holdings Corporation (PBH) Earnings Call Transcript & Summary

Good morning, ladies and gentlemen, and welcome to the Premium Brands Holdings Corporation First Quarter 2023 Earnings Conference Call. Joining us on today's call, we have from Permian Brands, George Paleologou, CEO and President; and Will Kalutycz, CFO. [Operator Instructions] This call is being recorded on Monday, May 15, 2023. I would now like to turn the call over to George Paleologou, CEO and President of Premium Brands. Please go ahead.

Thank you, Julie. And thank you for joining us today. With me here today is our CFO, Will Kalutycz. Our presentation will follow the deck that was posted on our website this morning. We're now on Slide 4, which outlines certain key highlights for the quarter. Results for the quarter were on plan as industry headwinds subsided. Our overall volume growth for the quarter was within our targeted range of 4% to 6%. However, the majority of the growth came from the foodservice channel as out-of-home dining returned and food traffic in retail slowed down somewhat. Consumers have resumed their regular activities. They're spending more time at the office downtown. They're traveling more for business and pleasure and they're consuming more food at QSR and in white tablecloth dining establishments. This, of course, means that they're eating and entertaining a little less at home. Return to normality for us means that once again, we're able to present our products and process innovations to the new and existing customers, and we are pleased to report that responses have been excellent. Innovation is back in vogue, and the premium brands ecosystem remains prolific in this area. Both our reporting platforms performed well during the quarter and are very well positioned to gain traction going forward. Demand for our cooked protein artisan sandwich and specialty bakery products was very strong while our center-of-the-plate, best-in-class protein offerings continue to drive the growth of our foodservice business. We're pleased to report that our new sandwich facility in Edmonton, Alberta is now ramping up and will be fully operational by the end of this month. The facility features automated, state-of-the-art sandwich assembly lines as well as industry-leading charcuterie trade assembly capabilities. We continue to gain momentum in growing in our U.S. businesses, and we expect this trend to accelerate in the months and years ahead. During the fiscal first quarter, 57% of our Specialty Foods platforms sales were generated by our U.S.-based businesses. Considering the many new listings we have secured recently and the current pipeline of opportunities, we have visibility to this number growing substantially in the future. We're now on Slide 5. You can see that our acquisition pipeline remains very full. Although we did not close any acquisitions during the quarter, we're pleased to report the completion or near completion of several capital projects that will solve a number of capacity challenges facing our various businesses, while improving efficiencies and enhancing productivity. Hopefully, you had a chance to watch the 3 videos we showed at our AGM on Friday. All 3 videos demonstrate the degree of automation and robotics we have been investing in over the past 3 years. Before I pass it to Will, I would like to reiterate that as promised, we're emerging from the past 3 chaotic years bigger, stronger and even more diversified. Our decentralized entrepreneurial-focused business model, combined with our great people and culture, continues to differentiate us, and we look forward to translating these competitive advantages into sustainable top and bottom line growth and above average long-term returns for our shareholders. As you can see on Slide 6 to 12, our prolific product innovation continues to disrupt and reinvent the various categories we compete in. Look for some of these products at a store near us. We're especially pleased to be bringing premium standard cut, super lean, best-in-class bacon to Central and Eastern Canada under the Leadbetter's brand. It won't be the cheapest bacon you've ever bought, but it will be the best you've ever had. I will now pass it on to Will. Will?

Thanks, George. Before I begin, I would like to remind you that some of the statements made on today's call may constitute forward-looking information, and our future results may differ materially from what we discuss. Please refer to our MD&A for the 14 and 52 weeks ended December 31, 2022, as well as other information on our website for a broader description of the risk factors that could affect our performance. We're now on Slide 14. Our sales for the quarter were $1.43 billion. This was an increase from 2022 of $179.3 million or roughly 14.3%. There were 4 major drivers of our growth. First and the largest was our organic volume growth, which was up $66.8 million. This was driven by the recovery in our food service and to a lesser extent, cruise line, bill checked sales to those channels. As George mentioned earlier, our artisan frozen sandwich programs, our cooked protein initiatives, which mainly are in the U.S. and our artisan baked goods initiatives, which are both in Canada and the U.S. Our organic volume growth -- sorry, our organic growth rate for the quarter was 11.7%, which is well above our long-term target of 6% to 8%. Turning to Slide 15. You can see on this slide from the chart, which shows our organic volume growth rate by quarter, the steady progress we've made over the last 4 quarters from a trough of 1.3% in the second quarter of last year, which was greatly impacted by the pandemic and inflation-related factors. And steady improvement over the 4 quarters, reaching 5.3% for this quarter, which is, in fact, the highest first quarter growth rate in our 5-year history other than the first quarter of 2020, which was heavily impacted by a pandemic-related demand surge. Compared to our expectations for the year, the first quarter's growth rate of 5.3% is low, primarily due to Q1 being a seasonally slow quarter as well as ongoing supply challenges with our Turkey, which good news there that we have seen some openings and some normalization in the commodities market, which is allowing us to re-enter that category this year. So we're excited about that. Turning to Slide 16. We reaffirmed our sales guidance for 2023 of $6.4 billion to $6.6 billion. Using the midpoint of this guidance of $6.5 billion, that would represent growth from 2022 of roughly $470 million or 8%. Turning to Slide 17. This slide shows our weekly sales. And the black line is for 2023 relative to the gold line, which is 2022. You can see we continue to generate solid momentum. The good news is FX translation and selling price increase impacts are lesser of a fact. And as we go forward, organic volume growth will be more of a factor. Turning to Slide 18. Our EBITDA for the quarter was $110.7 million. This is an increase of $14.9 million or 15.6% from 2022. There were 3 positive drivers and 4 major negative drivers of our results for the quarter. On the positive side, we continue to make great progress in recovery, in margin recovery with our selling price increases outstripping our raw material, freight and wage cost inflation by about $18 million in the quarter. We'll talk a bit more about that on the next slide. And then organic volume growth was the next biggest driver and finally, plant efficiencies, driven by recent investments we've made in automation and new technology. On the negative side, our plant overheads were much higher year-over-year. This was driven primarily by the ramp-up in capacity that we've been investing in, which will drive our growth in the second and third quarters of this year. Incentive-based compensation was also up due in part to our higher expected earnings for the year and free cash flow. Discretionary promotion was up, mainly due to the normalization of this expense post pandemic. And finally, outside storage costs continue to increase year-over-year due to our inventory levels, which I will be talking to in a later slide. Turning to Slide 19. Just gives you some progress we've made over the last 5 quarters on recovering our margins from the impacts of cost inflation. You can see that the first row shows our selling price inflation by quarter. And the third row, the net margin impact of our selling price increases after wage for raw materials and freight inflation. You can see from Q1 last year of a negative impact of $1.9 million, we made steady progress to roughly $18 million positive impact in the first quarter. Turning to Slide 20. Our EBITDA margin for the quarter was 7.7%, which was flat year-over-year. Q1 is generally a lower margin quarter due to the seasonality of our business and then other factors impacting our margin for the quarter was the significant unutilized capacity we've built up to support our growth in the second and third quarters. As I mentioned, that relates directly to the decrease in the plant overheads. And then also our bolt-on acquisitions that we completed in 2022, which are making great progress, but still have much lower margins than their projected margins. That resulted in about a 30 basis point dilutive effect on our EBITDA margin. And finally, the notice of period associated with price increases we're putting through, you've noticed on the previous slide, it was about $1.7 million in the quarter, much less significant from prior quarters as our pricing is catching up, but that was about 10 basis points of dilution in our EBITDA margin. So on a normalized basis, our EBITDA for the margin for the quarter was about 8.1%. Turning to Slide 21. We also reaffirmed our guidance for adjusted EBITDA for the year of $590 million to $610 million, using the midpoint of that guidance of $600 million. That would be an increase of roughly $96 million or 19% for 2022. We also are projecting a nice increase in our EBITDA margin for the year. Again, using the midpoint, that would be about 80 basis points over 2022. Slide 22. Our earnings for the quarter were down $10.8 million to $28.6 million, and our adjusted EPS was down $0.24 to $0.64 per share. There are 4 main drivers of the impact on our earnings. On the positive side was the growth in our EBITDA, which was about $14.9 million and lower income taxes, which is about $6.3 million. The major negative impact on our earnings and earnings per share came from the investments we've been making in growth. We estimate that impact from investing in capacity, which will set us up again for growth in the second and third quarter was about $19.6 million before tax or roughly $14.5 million after tax. And that consisted of interest on the capital we've invested and then additional lease and depreciation costs associated with those investments. Then the fourth factor impacting our earnings and earnings per share for the quarter was higher interest rates, which was an impact of about $12.3 million before tax or about $9.1 million after tax. Normalizing for the growth investments, you can see our earnings and adjusted earnings per share would both have been at record levels for the quarter. Slide 23. We finished this quarter with strong liquidity with $475 million of unused credit capacity. Our debt ratios did, however, remain relatively flat from Q4 at 4.3:1 for our total debt-to-EBITDA ratio at 3.2:1 for our senior debt-to-EBITDA ratio. Both these ratios are high due to our high inventory levels, which I will be talking to on a later slide as well as our strong capital plan for 2023. We do expect solid improvement in these covenants in the back half of the year as we grow our EBITDA and our inventory levels normalize. Turning to Slide 24. Our days cost of sales inventory at the end of the quarter were 65 days, which was a slight improvement for the first quarter of last year, which was 65.8 days. However, we still have lots of work to be done as we're still about 8 to 9 days over our historic levels. Our higher inventory levels for the first quarter were driven by 3 key factors. One was -- and you can see it from the chart below Q1 is just a normally strong inventory build period. You can see each of the last 5 years, Q1 has been sort of the peak point in our inventory cycle on a days cost of sales basis. And with all of the sales initiatives we're preparing for in Q2 and Q3, that was elevated in Q1 this year. Then we also had new sales initiative builds. We've got some very exciting sales initiatives launching in the second quarter, which we had built about $35 million of inventory for, which was unusually high level. And then we had an unusual level, high level of what we call opportunistic purchases where we were able to go into the market and buy raw materials at favorable prices, and that was about $27 million of additional inventory, which should contribute to better margins in the second quarter. Turning to Slide 25. For the quarter, we spent $62.1 million on project capital expenditures. These are expenditures that are expected to return or generate an internal rate of return of 15% or greater. $43.3 million of those expenditures were on 11 major projects, 7 of those are either complete or nearing completion with 2 more scheduled for early next year and 2 into 2025. Overall, the total expected investment for our projects underway is about $642 million, of which we spent about $180 million, leaving $463 million spent over the next couple of years. That concludes the financial presentation. With that, I'll hand it back to the moderator.

[Operator Instructions] Your first question comes from Martin Landry from Stifel GMP.

My first question, in your opening remarks, you're talking about unused capacity utilization is having a bit of an impact on your EBITDA margins. I was wondering if you can put a number to that. What was your capacity utilization during the quarter? And then you were talking about expecting it to improve in Q2 and Q3. So I was wondering what was your utilization this quarter? And where do you see it going in Q2 and Q3?

Yes. We don't have a utilization number, Martin, just because we're a portfolio of businesses, and they're all at different levels. So it's really hard to come up with 1 percentage that summarizes everything. But they range from -- some of our sandwich facilities are sort of 70% to 75% range, some of our meat snack facilities 60%. We've got lots of capacity, particularly with what's coming on stream now and in -- sorry, that came on stream at the end of the first quarter and is coming on stream in the second quarter to certainly exceed our sales expectations for this year.

Yes. So Martin, we have 115 facilities across the network. And so there's quite a range of capacity utilization. As Will said, in general terms, the second and the third quarter are by far the busiest for many reasons having to do with the weather, in particular. People eating outdoors, barbecuing all of those things. And when you run a plant at 60% capacity, you're still running with the same type of overhead, right? So as you ramp up to 100%, that improves your efficiencies and new productivity immensely, right? So generally, the first quarter is impacting -- margins are impacted because of the low utilization of the facilities.

And just to give you a sense of the impact on the quarter, Martin, our EBITDA -- the impact on EBITDA plant overhead increase was close to $6 million. A lot of -- there's a little bit of cost inflation of that, but a lot of that is just building that infrastructure now to support our sales for the balance of the year.

Okay. That's helpful. And it's a good segue into my next question. Again, in your opening remarks, you've talked about an inventory built up. I think you mentioned $35 million that was related to new sales initiatives. Could you share some of those new sales initiatives that you have lined up that are going to be unveiled in the next quarter?

Yes. So just to correct the comment, Martin, Will was referring to one specific sales initiative with the expected sales being in that range. There's, of course, many sales initiatives in the pipeline of premium brands going to the second quarter. Right? And as we've talked before, and as you know, we don't talk specifically about customers but with increased capacities in the areas of both sandwiches in particular, meat snacks, there's a lot going on with regards to opening new channels and finding new markets for our products.

Yes. But just to George's point, Martin, it is primarily driven by a number of sandwich initiatives that are new. And we don't include in that factor, the normal sort of seasonal buildup for ongoing sales initiatives.

Okay. I see. And then last question for me. With regards to the overall environment and the customer confidence being a bit shaky right now, are you seeing your private label products or your growth in private label sales being faster than your growth in branded products? And could that have a bit of an impact on your margins or not at all?

I wouldn't say that's an issue for us, Martin. As we've mentioned in the prepared comments, what's happening right now is that we're basically back to normal and I think consumers, as you know, are having a bout in traveling and getting on airplanes. And I think you're seeing that in all the data that's coming out. So there is less entertaining and eating at home. Obviously, that translates into reduced traffic through certain channels. We've always emphasized the importance of selling through diversified channels as a business overall. And we're really happy with our diversification. And again, as you've seen during the quarter, we picked up sales in the food service channel and maybe lost a little bit of traction in the retail channel as consumers are eating out more frequently.

Your next question comes from Stephen MacLeod from BMO Capital Markets.

I just wanted to circle around on the margin. You gave some good examples or some of the reasons why margins came in a little bit below expectations in Q1. Some of the headwinds that you're seeing. As you work towards that full year margin in the 9% plus range, do you expect to get most of those gains kind of in Q2, Q3 as you realize the benefits of these new sales initiatives?

Yes. So going forward, the 2 big drivers of our margins will be growth in our Specialty Foods segment, which will be leveraging the -- most of the capacity we've invested in over the last year is in our Specialty Foods segment. And it's a much higher margin business, much higher contribution margin. So that certainly is the biggest driver. And then the investments we've made in plant efficiencies. In the quarter, our plant efficiencies number was up about $5 million through primarily automation and other kind of investments in new technology. So those are going to be the 2 big drivers. And so as you fold that out over the quarter, the automation is something that's going to be sort of equal in Q2 to Q3. But in terms of the sales, the ramp-up is certainly we're going to see some benefits in Q2, but Q3 will be the full quarter of those benefits. We're expecting that certainly to be our highest margin quarter of the year.

Okay. That's helpful. And then just along those lines, I mean you talked about capacity challenges. Is that all sort of wrapped in together with what you expect to see in Q2 and Q3 as you -- some of these investments come on or you reap the benefits from these investments? And is that where you expect to see the capacity solutions kicking in?

Yes, absolutely. Those are -- we've talked in the past about, particularly around sandwiches and some of our protein categories, cooked protein in particular, and even artisan bakery goods being real bottlenecks and those are the bottlenecks we're addressing.

Your next question comes from John Zamparo from CIBC.

I wanted you to get back to capacity and particularly within the sandwich platform. And we spoke last quarter about how you weren't able to service all the sandwich customers you wanted to because of a combination of lack of capacity and just how fast your largest customer is growing. So I think you've said in the previous question -- or one of the previous questions, you're now at 70% to 75% capacity in sandwich. So I wonder how quickly can you fill this capacity? Is there kind of a waiting list of customers that you could quickly onboard? And I think the next expansion within sandwich is Columbus early '24. So can you just confirm that for me, please?

Yes. So starting with your last part of your question, you're absolutely right. That's when Columbus is scheduled to come on Q1 2024. Again, you'll see -- we're sort of pushing up against the capacity of our sandwich group throughout the next 2 years. And that's why we've already started on the Tennessee plant, which is scheduled to come online Q1 2025. We'll be -- based on the outlooks and the discussions we've had with the customers and potential customers, we're going to be pushing that capacity pretty quickly and scrambling right through until 2025.

But that's a good problem to have, John. And again, as Will -- just to answer your earlier question, we're not just onboarding 1 or 2 customers, we're onboarding a lot of customers. What we have, what we offer to the industry is in very high demand. We're really happy to be commissioning the Edmonton facility. We've had lots of innovation sessions and lots of visitors with regards to customers wanting that capacity as we speak. So there's a lot going on in that platform. In addition to that, because we have such a lead in that area, we seem to be taking market share as well. This is something that we've never done because this has really been a white space for us, but we're even seeing opportunities to take market share as well. So there's a lot's going in that pipeline, a lot of exciting growth initiatives in that platform.

Okay. Understood. And sticking with some of your different projects. You have multiple large ones underway. And I wonder if we're trying to figure out what's going to have the greatest impact on EBITDA? Is it as simple as looking at what you're spending on these? Or are there 1 or 2 projects that are going to over contribute when it comes to EBITDA improvements among your project CapEx?

There's 1 outlier that our San Leandro bakery initiative, john. These products are absolutely amazing. They are, to George's point, whitespace products that are just we can't keep up with the demand of our customers that are wanting us to take them into new markets. And they're good, solid contribution margin products. So that's certainly -- and you can see from the CapEx spend, it's a pretty material project. So that's probably the outlier. After that, the size of the project is a good indication of the impact on our margin.

And the biggest impact, again, John, overall in our margin, is going to be getting back to normal, right? You have to understand that in the last 3 years, we had amazing challenges accessing labor. We got supply chain issues and of course, inflation. So you have to look at our margins today in that context. If you assume normalization which we're seeing, that will have a big impact in terms of our margins.

Understood. Okay. A question on Clearwater. And the loss this quarter was larger than what we typically see. And you listed some of the reasons in the press release. And I know Q1 is seasonally the softest quarter in that business. But can you elaborate on how Clearwater is performing? And can you give any color on their access to the liquidity to pay your expected interest and fees?

Yes. So yes, there's no doubt, there was sort of a variety of challenges in the quarter for Clearwater. Most of them just that just sort of temporary challenges, some weather-related issues, just the timing of some inventory sales. Some of that they or a good portion of that, Clearwater is expecting to make up in the back half of the year. So we are expecting them to be on plan for the year. The reality is, John, and it's one of the reasons we structured the transaction as we did is there's expected to be volatility in their business because of things like catch rates and weather. And Q1 is exactly that. But for the year, no, we're still very positive on the year for the business and expect a decent cash flow coming in to pay -- what essentially is the stripping the free cash flow of the business but our interest payment.

And I would just add to that. We've worked with Clearwater's management team for the last couple of years to reconfigure the business plan, the overall long-term business plan towards more value-added and branded products. And we're making very good progress in regards to that. A few possible downstream type of acquisitions in the pipeline. So again, the plan is on track and on plan.

Okay. That's helpful. And then just 1 more on margins, and then I'll pass it on. The elevated inventory levels that you've held so far and understood why you make them, there's opportunistic raw material prices you're getting. But can you say to what extent, if any, this has benefited margins to this point? Or is that a future margin benefit?

It's largely a futures margin benefit. To the extent we made some opportunistic buys in the last quarter or Q4 that we did carry into Q1 and used in Q1. But the reality is that was part of that margin normalized. It's captured in that $18 million margin normalization. So there is a little bit of that. But in terms of the $27 million of unusual buys, that is all for Q2, Q3 this year.

Your next question comes from Derek Lessard from TD Cowen.

I just wanted to maybe -- I had 1 just maybe give us an update on sort of your seafood initiatives in the broader sense and when you expect to really start seeing the benefits of those investments?

Well, there's a lot going on in seafood, Derek, and I did speak to it a little bit at our AGM on Friday. We are quite advanced in announcing a Clearwater West type of transaction, involving certain indigenous First Nations, Coastal First Nations in BC. We've made a number of investments in value added, both in our soup business. We've launched a number of [ sour ] type of soups in Canada and the U.S., and we are launching more. We're also launching them into -- with customers in Asia as well. And then with one of our companies here, we've launched a number of value-added seafood and branded initiatives into retail mainly. As I mentioned earlier, with Clearwater, we're working on a number of acquisitions that will move them into the value-added space. So there's a lot going on. There's some pictures in the deck that shows you some of the seafood products we're launching or we've launched, including a wonderful Lobster Macaroni and cheese product. And anyway, there's a lot going on in the pipeline with regards to value-added seafood initiatives.

Your next question comes from Chris Li from Desjardins.

And maybe I'll start with a specific question just on the Specialty Foods organic volume growth in the quarter. Was the year-ago comparison, particularly a bit more challenging because there were 5 or 6 weeks of Omicron shutdown where everyone was eating at home and therefore you benefited from the excess demand in the retail channel from a year ago.

Yes, a little bit, although that was more of an issue in 2020, Chris. By 2021, 2022, it sort of had steadied and again, this year, we're -- it was a bit of a headwind, but there are different headwinds Q2 last year. So I think overall, the 5.3% shows a good sort of real trend happening in the group.

Okay. And can you maybe talk about specifically on the Specialty Foods segment, the organic volume growth, how is that trending so far Q2 to date?

Yes. Well, it's early, Chris, and things are just ramping up now. The May long weekend is kind of the big starting point for Specialty Foods with the turn in the weather. But so far, it's on plan. It's looking good. And as we showed in our weekly sales chart, we continue to generate good year-over-year weekly sales growth. And I should comment, too, that Q1 is likely the last quarter that you see that big growth coming from food service whereas by Q2 last year, you're already seeing that normalization. So the growth being driven now is in the Specialty Foods segment.